With second quarter of 2011 registering an impressive 8.2% GDP growth and year to date at almost 8%, unemployment at 5.2%, inflation at 11-month low at 6.4% and exports growing by 30% plus in 2011 YTD, Sri Lanka appears to be back in a sweet spot already. We believe that the economy, backed by its visionary policies, is likely to grow at 8%+ over the next decade. The recent discovery of natural gas in the Mannar basin is likely to raise investor attention on Sri Lanka further. Our 2011/2012 GDP growth forecast stands at 8.5% / 9.0% with some downside risks in 2011. We have seen concerns over domestic inflation waning in the last few months, with inflation likely to moderate to ~5% by year end. Not surprisingly, the CBSL kept rates on hold to support growth. We believe that the easing of inflation provides scope for the central bank to even cut rates, if global headwinds intensify further.
Economy grows at 8.2% in Q2: Sri Lanka’s Q2 GDP growth came in at 8.2% YoY as against 7.9% clocked in the first quarter. The higher investment levels coupled with the central bank maintaining lower interest rates has resulted in sustenance of the growth momentum post the end of the civil war in 2009. The services GDP grew at 8.8% YoY as against 8.6% in the same quarter last year (see chart). The central bank has recently lowered the 2011 growth forecast to 8.3% from 8.5% earlier citing a major decline in agricultural activity in Q1 due to massive flooding at the beginning of the year.
Inflation continues to moderate: Consumer price inflation moderated further in September to 6.4% YoY from 7.0% in August (against our estimate of 6.2%). Improving food supplies have helped cool off domestic inflationary pressures in the aftermath of the devastating floods in the first quarter of 2011. The latest inflation numbers have boosted scope to leave interest rates unchanged and shield growth as the global recovery weakens. Headline inflation is likely to drop further to 5% levels by the end of the year.
CBSL keeps interest rates unchanged: The Central Bank of Sri Lanka has left the interest rates unchanged for another month. Recent fall in international commodity prices, improved domestic supply conditions and the stability of the Sri Lankan rupee have helped contain domestic inflation. The latest moderation in headline inflation is a major relief for the CBSL which has held the rates constant to promote economic growth in the economy. On the money supply front, the M2 grew at 20.6% YoY as of August 2011; however it is expected to moderate in the period ahead given the decline in excess liquidity in the money market.
Exports grow 9.4% on higher base: Sri Lanka’s exports/imports for the month of July 2011 rose 9%/58% to US$ 957mn/1.77bn respectively. Exports growth slow in July due to the high base of July 2010, and was mainly led by the industrial sector, particularly diamond and jewellery (87%) and machinery and equipment (87%). The rise in imports is mainly fuelled by higher petroleum imports (135%) and building material imports (68%).
In the first seven months of 2011, the economy recorded a balance of payments surplus of US$ 1bn, with official foreign reserves climbing to US$ 8.1bn (5.7 months of imports). The services sector showed a surplus of US$ 461mn with workers’ remittances amounting to US$ 2,922mn. Foreign inflows, including the US$ 1bn sovereign bond was US$ 2.7bn and net FDI was at US$ 413mn, creating a balance of payments surplus of US$ 1bn. Relaxation of exchange controls had allowed 14 companies to borrow US$ 197mn abroad by September 2011 and 20 new foreign companies had started business in Sri Lanka.
We have a continuing coverage on the Sri Lankan economy, along with some large cap companies. Please let us know if you would like to discuss.
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